FINN 3058 Chapter #9
Describe the structure of an ARM
typically structured so that there is an initial interest rate that remains fixed for a certain period of time ranging from 1-10 years. Then after that time period the interest rate increases or decreases depending on the reference rate of interest.
FNMA and FHLMC were are still in conservatorship, their shares of stock are no longer listed on the New York Stock Exchange, and their future is a topic of much debate
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MORTGAGE BACKED SECURITIES
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Mortgage Backed Bonds
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Mortgage Insurance
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Mortgage Qualification
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Question for Dominck... Explain the assumption of risk between lenders and borrowers
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Review measurements of credit worthiness for borrowers on p.279 & p.280
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The National Housing Act created Federal National Mortgage Association (FNMA) for the purpose of developing a secondary market for FHA- insured mortgages.
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The interest rate can never be changed solely at the lender's discretion.
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Rollover mortgages (ROM) and renegotiated rate mortgages (RRM) protect the lender from being locked into a long-term low rate of interest
... the interest rate is reset to prevailing interest rates at a predetermined periods
Fannie Mae and Freddy Mac
p.287
CMO Collateralized Mortgage Obligations
p.288 ??`
What is the difference between Ginne Mae I MBS and II MBS?
1MBS= based on a pool of mortgages of the same type, having the same interest rate, and having the same lender. 2= Multiple lenders and interest rates that very nearly 0.75 percent
Explain what a 3/1 ARM means?
3 year fixed rate and then after that period the interest rate is subject to change annually
What is the most popular standard mortgage? Time duration and type
30 year fixed rate mortgage
An ___ is a mortgage with an interest rate that adjusts periodically in response to changes in market conditions.
ARM Adjustable Rate Mortgage...
For homebuyers who are planning to build there own home, which mortgage would make the most sense?
Construction-to-permanent Mortgages
What are pass-through mortgage securities?
Ask John Dominick
___ ___ mortgages have a relatively low fixed rate of interest for a predetermined period of time (typically 7 years)
Balloon Payment Mortgages
Why do lenders like ARM?
Because ARM helps lenders reduce interest rate risk by passing them off to the borrower. Thus, lenders are willing to "pay" borrowers to assume interest rate risk by offering lower rates on ARMS than contractual rates for long term FRMs
Although ARMs help lenders reduce their interest rate risk, they might increase lender's ___ ___. Why is this?
Credit Risk... If rates rise sufficiently, monthly payments could rise to the point that the borrower is unable to make the monthly payment. The credit risk of the loan would rise and the default could occur.
Mortgages can either be conventional or federally insured. Mortgages whose ultimate payment is gauranteed by the Federal Housing Administration (FHA) are called ___ mortgages
FHA... these have terms that comply with FHA requirements, and a small fee is added to cover the costs of insurance
Who devised the credit score methodology?
FICO (Fair Isaac Corporation) on a scale of 300 to 850 and those below 650 (dominick says 640) and usually considered subprime
What is Federal Home Loan Mortgage Corporation?
Freddie Mac is a subsidiary of the Federal Home Loan Bank System. Its initial purpose was to assist savings and loan associations and other mortgage lenders in attracting capital market funds and provide competition for FNMA. Like FNMA, FHLC was established as a private corporation.
What was (FNMA) split into?
GNMA and FNMA
GNMA additional description
GNMA does not originate or purchase mortgages. Rather, it provides a guarantee for mortgage-backed securities issued by approval lenders. GNMA was established as a government agency. It is wholly owned by the U.S. government, and its securities are the only mortgage-backed securities explicitly backed by the full faith and credit of the U.S. government
In 1968 FNMA was split into two entities, The Government National Mortgage Association (GNMA-Ginnie Mae) and the Federal National Mortgage Association (FNMA-Fannie Mae)
GNMA does not originate or purchase mortgages. Rather, it provides a guarantee for mortgage-backed securities issued by approved lenders. GNMA was established as a government agency. It is wholly owned by the U.S. government, and its securities are the only mortgage-backed securities explicitly backed by the full faith and credit of the U.S. government
Explain what GNMA's role is and what they do?
GNMA was given the charge of expanding affordable housing by helping lenders access capital markets as a source of funds for government- guaranteed mortgages. Today, GNMA guarantees the timely payment of principal interest on pools of qualifying FHA, VA, and other government-guaranteed mortgages. Lenders combine qualifying mortgages into pools, acquire a GNMA guarantee on the pool, and then sell security interests in the pool.
Discuss IO and PO factors of STRIPped mortgage backed securities (SMBSs)
Holders of the Interest-Only (IO) security are based solely on the interest payments being made on the underlying pool of mortgages. Principal Only (PO) only receive principle payments
example of subprime loan
If a property being financed by a mortgage is in a geographic region that experiences a substantial decline in property values, the mortgages loan to value ratio will increase. Consequently, the perceived likelihood of default on the mortgage may increase to the point that the mortgage is considered subprime.
Explain how a RAM works?
Instead of paying monthly payments, the borrower receives them. Many of these bonds are guaranteed for the life of the borrower and the loan plus accrued interest is paid when the borrower dies, sells the home, or is no longer able to live in the home
Which market is the largest of the long-term debt markets
Mortgage Market
___ are loans for which the borrower pledges real property as collateral to guarantee that the debt will be repaid.
Mortgages
Are privately issued MBS's given a government guarantee?
No, privately issued MBS dont receive a guarantee which often leave the issuer responsible for insuring these securities with insurance bc many of the underlying mortgages will be sub-prime
Characteristics of Mortgage Backed Securities
P.284 MBS chart on 285-286
___ are issued by private institutions or mortgage bankers, which pool mortgages, obtain private mortgage insurance, obtain ratings from the security issue and sell the securities using underwriters' services to compete for funds in the bond markets
PIP's Privately Issued Pass-throughs
Ask professor about blue section on p.275
Payment structure of ARM and interest rate risk reduction of ARM
___ ___ Mortgages are designed for older people who own their homes and need additional funds to meet current living expenses but do not want to sell their homes
Reverse Annuity Mortgages... allow people to borrow against the equity in their homes at relatively low interest rates
What must an ARM borrow be careful of especially when evaluating the payment of the first year?
Teaser rates... these are especially attractive rates that differ from the rest of the repayment schedule to entice buyers
The value of the IO security, however, tends to decline (increase) as interest rates decline (increase). As interest rates
p.289
What does it mean if someone has 1% ownership share in a pool of securities?
That person is entitled to receive 1% of all principal and interest payments made on the underlying mortgages
Ginnie Mae pass-through securities
The Government National Mortgage Association issues securities that pass through all payments of interest an principal received on a pool of federally insured (e.g., FHA, VA) mortgage loans
Historically the minimum loan-to-value ratio for a conventional mortgage was 80 percent... What does this mean?
The borrower had to put down a minimum 20% down payment in order to avoid taking out PMI private mortgage insurance
Explain the usage of PMI or Private Mortgage Insurance? When is it used, how is it used, and what is the benefit?
The lender of the mortgage can extend additional credit without bearing any additional risk because in the event of default the insurance company must pay. The borrower incurs an additional monthly expense (insurance premium) to cover the case of a hypothetical default. The insurance feature allows the borrower to buy a home with a far smaller down payment then otherwise possible. The consumer can cancel the PMI if the mortgage is less than 80% of the homes value.
What is the difference between ARM and ROM/ RRM
The number of years between interest rate adjustments is longer with ROM and RRM
How did the market limit default risk on ARM's
There is an interest cap placed on ARM... Typical caps are set at 1 to 2% per year or 5% over the total life of the loan
Why are pass-through mortgage securities so popular?
They are sold in standard denominations and readily marketable
Explain Balloon Payment Mortgages? what does balloon refer to and who is attracted to these loans?
This type of loan is popular with borrowers who plan to sell or refinance within a few years and want a low payment until that time. The balloon payment is a term coined for the large payment due at the end of the the period as a result of the small interest and principle payments due throughout the life of the loan.
Why was the (FNMA) Federal National Mortgage Association created?
To create a secondary market for FHA-insured mortgages
Describe the characteristics of a Mortgage Loan
Typically repaid in monthly installments that include both interest due and repayments of a portion of the principle due on the loan
Which mortages usually have very low or zero down payment requirements, so that people with such mortgages can borrow nearly all the money needed to buy a home?
Veterans Administration and FHA
Who issues mortgage backed bonds
fannie mae and freddie mac, private groups, and state and local government
Why are FNMA and FHLMC referred to as government-sponsored enterprises? (GSE's)
becauce they were privately held corporations but they were created by the government, received some government support, and assumed some public responsibilities. Although they werent backed by full faith and credit it was assumed and implied
Describe Home Equity lines or HELOCS
created so that homeowners can borrow against the equity they have accumulated in their home
Describe what FNMA does and who they are
created to help lenders access capital markets as a source of funds for CONVENTIONAL MORTGAGES. Unlike GNMA, FNMA was established as a stockholder-owned corporation when it was split from GNMa. Also unlike GNMA, FNMA purchases conventional mortgages from lenders. FNMA purchases mortgages for its own account, but it also issues securities backed by pools of the mortgages it purchases.
___ ___ is taking out one loan to pay off many others. Possibly with hopes to lower interest rates
debt consolidation
Explain Interest-only mortgages...
great way for borrowers to secure financing with low payments is too borrow through interest only mortgages. Only pay interest for the first 3,5,7,10 years. After that payments are increased to ensure amortization by 30 years
Understand the process for Standard Fixed Rate Mortgages (FRM)
in traditional FRM the lender takes a lien on real property and the borrower agrees to make periodic repayments of the principal amount borrowed plust interest on the unpaid balance of the debt for a predetermined period of time. The mortgage is amortized over time to the extent that the periodic (usually monthly) payments exceed the interest due; any payment in excess of interest is credited toward repayment of the debt. Until the debt is paid the lien prevents the owner from selling the home without paying the lender back in full.
In typical residential mortgage loan, the primary source of repayment is the borrower's ___.
income
What factors are taken into consideration when looking for Mortgage approval?
income level, the amount available for a down payment, credit history, and other financial obligations
Historically, the most important determinant of whether a borrower defaults on a mortgage loan is how much of his or her own money is put toward the purchase of the property.
know this.
Are conventional mortgages insured by federal government agencies?
no
What is one large reason some borrowers choose an ARM compared to a FRM in relevance to the payment structure?
payments are often initially more affordable with an ARM... However if you repay an ARM before maturity you often have to pay a penalty payment
What are Adjustable Rate Mortgage interest rate adjustments based on?
published market index, such as the weekly average yield of 1-year U.S. Treasury Securities, the Cost of Fund Index (COFI), or the London Interbank Office Rate (LIBOR)
As interest rates decrease, the holders of a PO security expect to receive the principal amount (sooner or later) and the value of the security (increases or decreases)?
sooner and increases
What is the order of payment between first and second mortgage issuers in the event of default?
the first mortgage issuer is always repaid first... second mortgage issuers have increased credit risk
Explain what a Construction to permanent Mortgage entails?
the purchase of the land and the construction of the home are financed in increments, with the borrower paying only the interest payments during this phase. Once construction is completed the remaining outstanding balance is rolled over into an FRM, ARM or one of the other types of mortgages.
Why do mortgage borrowers often repay the full amount early?
they move or refinance their home
Why are ARM's popular with lenders?
they reduce the lenders interest rate risk. When interest rates rise, borrowers adjustable -rate mortgage payments also rise (after the initial fixed rate period)
Read the mortgage example on page p.272
whenever you pay more in the beginning in repayment the interest amounts become smaller as time goes on
Why would borrowers be willing to pay more for FRM compared to ARM?
with FRM issuers assume the interest rate risk, not the borrower.
